Sophisticated investors are today uncovering greater long-term returns by investing crossborder. However, as the volume and complexity of global investing increases, delays and errors in processing trades and settlement instructions have accelerated market participants' desire to search for a more automated, efficient approach.
Language barriers, time differences and physical distance combined with short settlement periods increase the risks for all security trading participants. While the current suite of electronic trading products have reduced the risk for the investor and the executing broker by automating the confirmation process, none of the products has provided an efficient method for routing settlement instructions to agent banks. Banks are forced to rely on a variety of manual methods for receiving settlement instructions from their counterparties. These settlement instructions are often received by the bank after the trade is supposed to settle and often contain multiple errors. Banks are required to employ large staffs to chase down settlement instructions, repair messages, and to manually match settlement instructions with executing brokers' instructions prior to settlement taking place.
An example of the way the underlying transactions occur for which matching is typically needed is as follows. Company A, Hong Kong, places an order with Company B, Philippines to purchase 1,000 shares of Securities C. To place the order, the originating broker at Company A telephones and faxes to Company B. Upon receiving the order, an executing broker at Company B executes the trade at the Makati Stock Exchange on Company A's behalf. Typically at the end of the day, Company B notifies Company A, Hong Kong that the trade has been successfully executed. The notification is followed by a fax transmission to the brokers' custodian and clearing agent where the actual fund and security transfer will take place. The entire process could take somewhere between a day and up to several days.
As evident from the above example, this process flows though several stages and tends to be time consuming and error prone. This problem is particularly acute when trading across wide time zone gaps, leaving tight datelines for settling trades and correcting any errors. For institutional money managers, brokers and banks, carrying unconfined trades on their books increases risk. Thus, delays in achieving confirmation are costly to financial institutions reducing the profit margin on these transactions.
Systems exist that permit securities traders to communicate electronically with each other. Each of these systems require the investor's clearing agent to manually pre-match a settlement instruction with the executing broker. Currently, there are no products that can effectively automate the trading confirmation process between brokers.
The Depository Trust Company ("DTC") of New York, N.Y., uses an ID system in the United States between institutional investors and broker dealers to confirm transactions for DTC eligible U.S. securities. This system does not operate on a central matching basis; institutions must wait for broker dealers to submit trade data for which they must provide an affirmation. For non-DTC eligible securities, the institution must send a message to its clearing agent notifying them of a securities transaction. The institution's clearing agent must manually pre-match the settlement instruction with the executing broker instructions before the actual settlement can occur.
Thomson Financial of Skokie, Ill., provides the OASYS Global service, which also allows institutions and brokers to confirm transactions. OASYS Global, however, does not offer centralized matching and does not automatically generate settlement instructions and route them over the Society for Worldwide Interbank Financial Telecommunication (SWIFT) Financial Network. Additionally, OASYS Global message formats are not based on the SWIFT standards.
The London Stock Exchange SEQUAL product offers a centralized broker to broker matching facility; however, SEQUAL does not generate settlement instructions to clearing agents and its message structures are not based on SWIFT formats.
U.S. Pat. No. 5,497,317 discloses a device and method for improving the speed and reliability of security trade settlements, in which trade settlement information is communicated securely between institutional investors, brokers, and custodians. As defined in this patent, institutional investors consist of retirement and pension finds, mutual fund companies, investment advisors, insurance companies and other investors, which manage and trade for two or more accounts. Custodian is defined as a bank, security depository or other settlement agent. Delivery instructions are stored in database in a format compatible with both Industry Users Group (IUG) and Industry Standardization for Institutional Trade Communication (ISITC) standards. Communication links exist between security trading participants and a central database (which actually consists of two separate databases), and between the participants themselves for exchanging messages (e.g., electronic mail not relating to settlement of a particular trade). Communications links between institutions and brokers are utilized immediately after trade execution to settle the trade. Similarly, trade settlement communications links exist between institutions and custodians. Brokers and custodians input delivery instructions to a delivery database along respective lines. The delivery instructions include information such as the country of origin of the security, the security type, and clearing method details. As delivery instruction sets are added to or modified on the delivery database, alert messages are generated by a central database for communication to the other brokers and custodians; these alert messages inform the brokers and custodians of the delivery instruction changes. The central database includes a wire or wireless transceiver for receiving information for storage and retrieval requests, and for transmitting alerts and retrieved information. Account information includes a custodian identifier for retrieval from the delivery database of the delivery instructions corresponding to the specified custodian identifier. Account information and the retrieved, specified custodian delivery instructions are combined for storage in an account database. A broker internal account number (BIA)/account identifier table is stored in the account database for use by the central database to generate alert messages for transmission to brokers informing them of changes in account information for BIAs cross-referenced to the account information. The changes may be to either the custodian delivery instruction portion or the account portion of account information. Information retrieved from the central database for use in settling security trades is very accurate since each participant enters information on databases pertaining to it and since alert messages permit affected participants to review changes made to the databases in real time.
In this system, storing custodian delivery instructions in both the delivery database and the account database serves several functions. First, it prevents custodians from making changes to the settlement of securities traded for an institutions' account without the institutions' consent. Second, it permits more rapid retrieval and transmission of security settlement information from the institutions to the brokers since only a single database needs to be accessed.
This system, however, does not provide for direct broker to broker confirmation, in which a secure communication is maintained between the brokers. Furthermore, this system is not compatible with standard message formats in the financial network.
The challenges in crossborder trading are extremely acute. The time difference between counterparties can be as great as 12 hours. Fail rates in certain markets are as high as 30%. Existing processes--laden with outdated technology, a lack of industry standards, and insufficient infrastructure--lead to such errors and their resulting high costs. The market is demanding the following: accommodation of the breadth, depth, and complexity of transaction activity; facilitation of execution and settlement with multiple counterparties; accomplishment of straight-through processing of transactions; evolution of "legacy" systems into "open, interoperability" systems; and leveraging of advanced technology to handle a greater share of all such transactions.
It is thus clear that a system is needed for automating matching of transactions among brokers and custodians, especially for use in conjunction with the SWIFT network or other financial networks.